The Fund fell 6.8% during the month, in line with the Fund’s benchmark index MSCI Pakistan IMI Net TR (SEK) which fell 6.6%. Minor negative contributions (0.4%) were mainly received from our stock selection in Materials, primarily cement & steel companies, where we saw a rebound of between 10-15% after a couple of strong months. We also lost marginally on the more cyclical portion of our exposure in Consumer Discretionary where both Pak Suzuki Motors (car manufacturing) and General Tyre (tire manufacturing) lost 15% and 23% respectively in February. Marginal positive contributions were received from our only exposure in the IT sector, Systems Ltd, which remained unchanged during a fairly weak month. We also earned on our underweight in the energy sector, which developed poorly in the wake of the lower oil price. In February, we increased slightly in the cement sector, where we believe expectations of lower interest rates may increase interest given the relatively high indebtedness. No companies were sold and no new companies were added during the month.

MARKET

In February, MSCI Pakistan IMI Net TR (SEK) declined by 6.6%, MSCI FMxGCC Net TR (SEK) fell 6.1%, and MSCI EM Net TR (SEK) fell 4.3%. The negative performance of the market during the first half of the month was attributable to an unexpected increase in January’s headline inflation, which reached a 12-year high of 14.6%, and inconclusive talks between the IMF and Pakistan on the second review of the program. The market performance in the latter part of the month was particularly hammered by the confirmation of the first two cases of COVID-19 in the country. Also, in February, FATF decided to keep Pakistan on the grey-list for another four months till June 2020 (a decision in line with our expectations).

After a month-long discussion the IMF and Pakistan, on 27th February, reached a staff-level agreement on reforms and policies, thereby paving the way for Pakistan to receive the third disbursement of USD 450m in April (subject to the approval of IMF Executive Board). As the last two press releases from the IMF on Pakistan remained unforthcoming on the program’s shortcoming, however, the ruling government claims success in talks with the IMF by sidestepping the demand of the mini-budget along with a delay in energy prices hike.

As mentioned in our previous monthly comments, the rise in January’s inflation number was largely influenced by food inflation, which was caused by a supply shock in agricultural commodities. However, the timely intervention by the government to tame down food inflation by banning exports and allowing imports of few agricultural commodities along with legal action against commodity hoarders assisted in bringing down inflation in February to 12.4%, against the market consensus of 13.3%. Other important economic data releases during February continue to maintain their respective positive trajectories like CAD contracted by 36% YoY in Jan’20 and tax collection grew at 18% YoY in Feb’20.

So far, the officially confirmed COVID-19 cases stand at five with no report of any deaths in Pakistan. Also, the country has adopted several precautionary measures to minimize the spread of the virus. Needless to say, the virus would have an impact on the economy. Our initial assessment suggests that the ongoing threat of COVID-19 would provide short-term relief to the Current Account of Pakistan, given the trade disturbance is not prolonged beyond May. Pakistan’s balance of trade (both goods & services) is mostly dominated by deficits, where total imports and exports represent 22% and 10% of GDP. Given that Pakistan has the largest trade deficit in goods with China of USD 8.4b (or 29% of the trade deficit); therefore, we expect a slowdown in trade with China coupled with lower commodity prices (especially oil & steel) would help to ease pressure on trade deficit from March onwards.

With further declines in the prices of essential commodities and with the government’s decision to cut petroleum prices effective from March, the CPI is expected to further ease inflation during March. Before the announcement of the March inflation data, the central bank is expected to set the policy rate for the next two months. As we wrote in previous monthly letters, market consensus moved from a cut in March/May to July post the December CPI data. Post the January CPI number, the COVID-19 impact on commodity prices (in particular oil prices) we conclude that market expectations are now moving towards an earlier cut again. Our expectations are for SBP to keep rates unchanged in the March meeting. Based on recent events, we do however not exclude the possibility of a cut already in March which would be a positive surprise. Improving trade data and renewed hope for an interest rate cut is expected to improve local investors’ sentiment in March. The real game-changer yet to be seen is foreign buying. Foreign investors net sold USD 56m of equities in February alone and have been net sellers of USD 90m since the market bottomed in early August 2019. We believe this has very little to do in regards to Pakistan, but rather it is in line with what we see in a range of similar markets, caused by redemptions and risk aversion. A more positive sentiment on country-specific factors might thus be dampened by continued global volatility.

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